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Mci

PRESENTED: THURSDAY JUNE 15, 2006
MCI
CASE ANALYSIS
INTRODUCTIONMCI is at a critical point in their company history. After going public in 1972 they experienced several years of operating losses. Then in 1974 the FCC ordered MCI's largest competitor AT&T to supply interconnection to MCI and the rest of the long distance market. With a more even playing field the opportunities to increase market share and revenue were significant. In order to maximize this opportunity MCI required capital. Their poor financial performance required them to use less traditional instruments to obtain financing. The capital acquired supported their growth until they reached a level of profitability in 1978. Subsequently they continued to increase their net income and the quality of their balance sheet. With continued prospects for growth tempered with some regulatory uncertainty they need to determine their optimal financial structure for the future. CAPITAL REQUIREMENTS

MCI's capital requirements for the next 3 years are x,y and z. (see exhibit A). These values are based on a number of different assumptions. (See exhibit B). The forecast is not without a level of uncertainty. Specifically there are regulatory decisions where the outcome is not clear at this time. This could impact profit margin plus or minus seven percentage points. (See exhibit c) CAPITAL STRUCTURE

MCI current capital structure is x% debt and y% equity. Their key ratios are a, b, and c. Comparing to other firms in the utilities industry they appear to be underutilizing (debt/equity). (See exhibit D). Referencing the forecast there is expected to be an x% annual increase in net income which would support an increase in (debt/equity) and keep ratios within the range of other firms in the industry(see exhibit E) HISTORICAL FINANCING

Since going public in 1972 MCI has a number of different instruments to raise capital including common stock, convertible preferred stock, debenture, subordinated debenture and convertible subordinated debenture (see exhibit F). Essentially, MCI relied heavily on convertible debt. As their stock price rose, the debt was converted to equity. Jeremy Stein (1992) states that a "good firm will use convertibles because the firm's true value will be made known before the debt is due". Following Stein's observations, Jen, Choi, and Lee (1997) conclude that "convertible bond financing is an attractive alternative for companies that have large growth potential but find both conventional debt and equity financing very costly". MCI clearly had a vision for substantial growth. The MCI management saw an opportunity for financing that would result in issuing equity and leave the possibility open to acquiring more debt in the future, if needed. The advantage to choosing a convertible bond for financing is that "they provide issuers with cheap' debt and allow them to sell equity at a premium over current value". Jen, Choi, Lee (1997).

Subsequent to their initial public offering in 1971 which raised $27,070,000 by issuing 6,000,000 shares MCI required additional capital in 1975. They were able to raise an additional $8,165,000 of capital by issuing 9,600,000 units of common stock at a price of $1.00 per share. To increase the attractiveness of the offer a 5 year warrant was attached which allowed for the purchase of additional shares of stock at an exercise price of $1.25. This was the best instrument to use at the time considering their poor 1974 profitability results, profitability ratios and the stock price at the time. (see exhibit G). Given their positive prospects for growth the warrants provided significant upside for investors which helped to offset the high risk associated with MCI's financial performance at that time. Equally important to investors was the FCC decision in May of 1974 that required AT&T to supply MCI with interconnection. This ruling supported the possibility for increased market share and...

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...ASSIGNMENT QUESTIONS
MCI Communications Corporation (1983)
1-What is the likely level of MCI’s external needs over the next several years? By how much could they be expected to vary? Why?
2-Critique MCI’s past financial strtategy, giving attention to the types of securities on which it has relied. Why did MCI finance itself in the manner it did?
3-Based upon your analysis of the outlook for MCI and the competitive and regulatory evolution of the industry, recommend a capital structure policy for MCI and defend your proposal against plausible events.
4-Assume that Mr.English, the MCI chief financial officer, has the following financial alternatives available to him as of April 1983:
a)$500 million of 12 1/2 , 20 year subordinated debentures
b)$400 million of common stock
c1)$600 million 7 5/8 20 year convertible subordinated debentures with conversion price of $ 54 per share (i.e., $1,000 bond would be converted into 18.52 conmmon shares)
c2) $1 billion of a unit package consisting of a $1000 7 ½, 10 year subordinated debenture and 18.18 warrants, each entitling the holder to purchase one share of MCI common stock for 55$. The warrants would be exercisable until 1988 and are callable. The exercisei price of the warrants would be payable either in cash or by surrender of the debentures valued at their principal amount.
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...﻿“The MCI Takeover Battle: Verizon versus Qwest”
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3. Merger arbitrage (or risk arbitrage) funds speculate on the completion of stock and cash mergers, typically buying the target and hedging the risk of the acquirer’s shares accordingly to exchange ratio in stock mergers. What positions would risk arbitragers take in this deal? How would their positions change if the board appears to favour Quest offer?
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5. Which offer should MCI accept? Why?
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...Group Case 3: MCI Communications Corp., 1983
Executive Summary
Assumptions
The following are the assumptions we made through the whole analysis.
The predicted revenues from 1983 to 1990 were assumed to follow the pattern in Exhibit 9A, despite the uncertainty of the higher access charge and competition increase.
The marginal tax rate is 30% during that period.
The firm must keep minimal cash balance of $100 million to support its operating activities. However, the change of operating NWC is assumed to be zero.
Calculation
To calculate the external financing needs during the period 1983-1990, we need to calculate the net cash flow from operation (i.e. the free cash flow minus after tax-interest paid). Along with the cash at the beginning of the year and the required minimum cash balance, we can get the external financing need for each year. See detailed calculation in Exhibit 1.
However, due to the uncertainty of access charge change and competition, the operating margin would increase or decrease by as much as 7% from the prediction, although the management was committed to the predicted revenue levels. Therefore, the external financing needs would vary correspondingly. See detailed calculation in Exhibit 2, and 3.
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...MCI COMMUNICATIONS CORPORATION
Introduction
In 1982, the Justice department ordered the separation of ATT into local subsidiaries. MCI was one of the main competitors of AT&T and the impact of this new competition on MCI was uncertain. In this case the financial impact of this increased competition will be analyzed.
Analysis of External Financing Needs for MCI from 1983 to 1989
Please see Exhibit 1 and Exhibit 2 MCI’s external needs will keep increasing over the next few years as the operating margins would shrink because of higher competition & higher access charges. In order to increase its market share, MCI would need to continue investing huge capitals in its network. As per exhibit 9 of the case, it is anticipated that MCI will increase its market share to 20 % in the next 6 years. The telecom industry is very capital intensive and in 1983 required $1.15 worth of investment in fixed plant & equipment for each extra $1 of revenue; that is first you have to build the network before you can sign up customers. The operating margin is expected to stabilize at 15% by 1990. But they are expected to vary substantially based on competition. It can go up to 22% or go down to 8%.
Types of securities which were issued by MCI (1972-1983)
1. 2. 3. 4. 5. Common Stock Common Stock with warrant Convertible cumulative preferred stock - Cost Around 12.27 Debentures – Cost around...

...Homework #5
1) MCI initially financed its needs through equity issuance. This was done because MCI’s source of revenue was insecure in its infancy, and this allowed them to raise capital without being tied down by excessive debt repayments further down the road.
To continue raising capital after MCI began posting early profits (particularly to repay short-term bank debt), the company issued convertible preferred stock. This preferred stock was able to attract capital due to its dividend paying attributes, but prevented the dilution of common stock. The convertibility allowed MCI to retire these preferred shares into common shares when the preferred shares appreciated significantly, allowing the company to forgo expensive dividend payments.
As the company continued to mature and show that it was capable of remaining stable and profitable, it was able to achieve enough creditworthiness to raise capital through debenture issuances. At this point, it was also able to generate enough growth in profitability to also service the repayment of this corporate debt for the foreseeable future.
2) External financing can be defined as the difference between total capital expenditures and EBIDTA. According to MCI’s baseline forecast, the amount of external financing needed for the years between 1984 and 1988 is:
[figures in millions] FY1984 FY1985 FY1986 FY1987 FY1988 TOTAL
Total capital expenditures 890 1,467 1,931 2,760 1,457...

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Background of Company
MCI communication corporation was a telecommunication company found in 1963. In the beginning the business plan of MCI was to build up a group of microwave relay stations that allow limited-range two-way radios signal to transfer. Which means providing long distance telecommunications.
In 1971, the Federal Communications Commission (FCC) allowed those long distance companies compete and try to break out AT&T’s monopoly telephone service in the U.S. MCI wanted to grow further, however the AT&T did not want to provide interconnection services which MCI needed. As a result, MCI sued AT&T in 1974 and later won the law suit and FCC force AT&T to provide service to MCI , thus MCI continue its construction on its own network build.
Before 1974, MCI was not profit too much but is all change based on their successful business strategy, knew as “Execunet” service they offer affordable service to those customers who could not afford AT&T’s service. MCI successfully attracted small business user and residential to use their services. Due to that success strategy MCI turning to very profitable. Because of that, MCI saw a really high potential growth opportunity that could bring the company to a different level. However, they find out the need more funds and capital to support the growth.
AT&T is...